New UK Pension Rules Could Trigger a 91% Tax Hit From April 2027: Who's Most at Risk

For years, pensions have been one of the UK's most tax-efficient ways to build wealth and pass it to the next generation. That advantage is set to change.

From April 2027, unused pension pots will generally be brought into the inheritance tax system. For some families, this could create a combination of inheritance tax and income tax on pension wealth passed to beneficiaries. In the most severe example calculated by NFU Mutual, a family could lose the equivalent of 91 per cent of a £700,000 pension pot to tax. The changes could have significant implications for people who have planned to leave their pension savings to their families.

Why Pensions Are Being Brought Into the Tax Net

Pensions have traditionally enjoyed an important inheritance tax advantage. Unused pension funds have generally remained outside a person's estate for inheritance tax purposes. This has made pensions an attractive option for people looking to preserve wealth for beneficiaries.

That treatment is due to change from April 2027 following the policy announced by then-Chancellor Rachel Reeves in 2024. Under the new rules, unused pension pots will generally be included when calculating the value of an estate for inheritance tax purposes. Inheritance tax is normally charged at 40 per cent above the available tax-free thresholds. However, inherited pensions can also face income tax depending on the age of the person who died.

Why Age 75 Matters

The age at death will remain an important factor in determining how an inherited pension is taxed. If someone dies before the age of 75, beneficiaries can generally withdraw inherited pension funds without paying income tax.

If the pension holder dies after 75, beneficiaries normally pay income tax on withdrawals at their marginal rate. This can mean tax at 20, 40 or 45 per cent, depending on the beneficiary's taxable income.

The supplied report cites official figures showing that the median age of death is 81.8 for males and 85.5 for females in England and Wales. This means many inherited pension pots could be subject to the post-75 income tax rules as well as the inheritance tax changes.

How a £700,000 Pension Could Face a 91% Tax Hit

NFU Mutual has calculated a particularly severe example involving a married couple. The couple has total wealth of £2.7 million. This includes a £1.7 million home, £300,000 in savings and investments, and £700,000 held in pension pots.

The pension wealth currently sits outside the inheritance tax calculation. Under the new rules, however, the £700,000 pension pots would be included in the estate. The size of the estate could also result in the loss of the residence nil-rate band. This allowance can provide additional inheritance tax protection when a qualifying home is passed to direct descendants.

According to NFU Mutual's calculations, the family could face an inheritance tax bill of £820,000. If the surviving beneficiary dies after 75 and the children withdraw the pension funds, NFU Mutual calculates that a further £219,326 in income tax could apply. The combined additional tax would amount to £639,326 when compared with the treatment of the pension under the current rules.

NFU Mutual says this is equivalent to about 91 per cent of the £700,000 pension pots. The example illustrates how inheritance tax and income tax can interact when pension wealth becomes part of an estate.

Smaller Estates Could Also Be Affected

The potential impact is not limited to families with multimillion-pound estates. NFU Mutual has also highlighted the case of a 74-year-old unmarried mother with a £500,000 estate and a £500,000 pension pot. Under the current rules, she could potentially avoid inheritance tax if her home passes to her children and the available allowances cover the estate.

From April 2027, the pension could instead be included when calculating the value of her estate. NFU Mutual estimates that £500,000 could become subject to inheritance tax at 40 per cent. If she dies after 75, income tax could also apply when her beneficiaries withdraw the remaining pension funds. NFU Mutual estimates that the total additional tax could reach £364,250, equivalent to 73 per cent of the pension pot.

What Pension Holders Can Consider

The changes could affect how people use their pension savings during retirement. Shaun Moore of wealth management firm Quilter said people should reconsider holding pension funds primarily as a way of passing wealth to beneficiaries because pension pots could face both inheritance tax and income tax.

One approach could be to use pension savings during retirement while retaining other assets, depending on individual circumstances. Sean McCann of NFU Mutual has also suggested that people could consider taking their 25 per cent tax-free pension lump sum at age 75. Money withdrawn from a pension would no longer be subject to income tax as an inherited pension withdrawal. However, it could still form part of the person's estate when inheritance tax is assessed.

Gifting Could Reduce the Value of an Estate

Gifting is another option available under existing inheritance tax rules. An individual can normally give away £3,000 each tax year under the annual exemption. Certain gifts can become exempt from inheritance tax if the person making the gift survives for seven years.

There is also an exemption for certain regular gifts made from surplus income, provided the relevant conditions are met. However, the supplied report quotes Marianna Hunt of Fidelity International as warning that people should consider whether they may need the money themselves in the future. Potential care costs and other living expenses can increase during later life, making it important to consider future financial needs before giving assets away.